Why tactful regulation is needed to tame the wild west of cryptocurrencies

Ivan Gowan, CEO at fintech company Capital.com, explores regulation around cryptocurrencies and what the future holds for this exciting technology

Regulation of cryptocurrencies is on its way, in some shape or form. Despite the creeping involvement of institutional investors and massive public interest, anxieties from politicians, consumers and investors are not going away. At the moment it seems like every other day that a story of crypto-market manipulation and scandal hits the headlines.

Cryptocurrencies and initial coin offerings (ICOs) offer smaller investors, who do not have the capital to invest in the next VC funded startup, the opportunity to make significant returns on different coins and tokens. However, consumers are at risk because of the lack of effective regulation around the market. Many stakeholders, from investors to regulators, are calling for an end to this lawless wild west environment and an end to the lack of market oversight. Others stress its libertarian foundations and warn that any move to regulate the technology would strip away its intrinsic value as a decentralised currency.

Extensive work is underway to better govern this roaring market and increase accountability. In the UK,the Financial Conduct Authority and the government are exploring how regulation could be developed to provide adequate protection for consumers and businesses without stifling innovation. We are also increasingly seeing regulators such as FINMA, Malta Financial Services Authority, and the Gibraltar Financial Services Commission, leading the way, embracing this innovation and issuing guidance and frameworks to companies looking to issue an ICO to ensure they do so responsibly and effectively.

At the moment, the consultation process is relatively disjointed, with each country reflecting on their own needs and producing policies independently. But international collaboration is on its way, with the G20 showing increasing interest in putting forward global recommendations and tackling some of the most prominent problems.

This is reassuring, as the market is cluttered with issues that require urgent attention. Fake ICOs, for example, are littering the internet with hollow promises of exponential returns on investment and long-term wealth. The situation is out of hand, with figures from the Wall Street Journal showing that over $1bn worth of investment has been stolen to date. Meanwhile, the scale of illegal activity that is being financed through encrypted currencies remains unknown. Europol predicts that criminals in Europe are using cryptocurrencies to launder as much as £4bn, comprising around 4% of all illegal activity. However, quantifying an all-encompassing figure for this is impossible.

So called pump and dump scams are another major area of concern for regulators and consumer protection groups. Social media and mobile messaging apps are increasingly being used by fraudsters to attract investors to put their money into cryptocurrencies, artificially inflating the value of the coin or token to very high levels. When the value reaches a certain point, those ‘in the know’ dump their positions in these coins, the value comes crashing down and those that weren’t forewarned risk losing everything they invested.

Calming fears

These issues must be addressed if the crypto market is to reach its full potential. The longer the market continues to be volatile and holds the potential for fraudulent activity, the more likely it is that the financial authorities will take a heavy-handed approach to regulation. Uncertainties on what form regulations will take are breeding constant difficulty in the sector, ensuring that investing in cryptocurrency continues to be a risky venture. The sector is clearly vulnerable to the whims of government, as its value consistently reacts to the comments of regulators and financial authorities. After Mark Carney, governor of the Bank of England, told G20 members that cryptoassets “hold no risk” in March 2018, bitcoin jumped by more than $1,000. There are numerous examples of cryptocurrencies reacting to instances of political and regulator rhetoric, highlighting a clear relationship between policy and performance.

Furthermore, an effective framework of regulations would likely calm the fears of institutional investors, who draw comparisons to the internet bubble of the late 1990s. Some financial institutions, such as Goldman Sachs, have moved away from outright denunciation of the market and are cautiously looking for ways to better meet the demands of their clients through participation. But we are yet to see a full-scale acceptance from the traditional financial services industry, and much of this is down to the air of uncertainty that surrounds the crypto market. Well thought out and balanced regulation would add some much-needed legitimacy here, further enhancing trust and acceptance within the investor community.

Better regulations

Sensible regulation will reduce volatility and facilitate safer trading, enabling retail investors to better capitalise on this exciting market. However, regulation could go as far as outright banning the development of cryptocurrencies, as has been suggested by the government of South Korea. As with all commercial regulations, the key is to strike the right balance between maintaining the market’s usefulness, and curbing its undesired effects on society. All interested parties must therefore participate in this debate, to ensure that these promising technologies can flourish. That way, the innovative nature of the market can be maintained, while it transitions to be more compatible with the world we live in.

Way forward

The technology behind cryptocurrency is developing exceptionally quickly, so it is the responsibility of financial authorities, industry leaders, and investors to ensure that any regulation that is implemented is relevant and applicable to where the market is heading. Regulators may struggle to keep up with the pace of technological development of cryptocurrency, and are only able to interpret, enforce and propose changes to the law, not make the law. It is therefore imperative that those with technical knowledge are involved in the decision-making process.

Well considered regulation would play a significant role in bringing stability and legal assurance to the cryptocurrency market, further incentivising acceptance from important players and enabling smaller investors to access opportunities to make good returns through legitimate ICOs and exchanges. There is no doubt that as regulators get up to speed with the technology and the big banks begin to adopt more open-minded positions, we will see an increasingly mature, safe, and less volatile market.